Sunday, August 21, 2011

Roubini's Off the Wall History of Financial Crashes

Nouriel Roubini is continuing his mad streak of tweets attacking those who see dangers in central banking, in general, and the Federal Reserve in particular. His tweets distort the history of banking and crashes from the 1700's to modern day. He begins:

I'm not going to conduct a financial history of the last three centuries in this post, but lets take a look at the first two dates Roubini lists 1772 and 1792.

In the first case,1772, there was a bank that attempted to inflate in Scotland, but it was a private bank and it didn't get very far. As Murray Rothbard suggested when private banks inflate damage is extremely limited. Ron Paul explained what happened in the period surrounding the 1772 bank collapse in Scotland:

In 1769 the Ayr Bank in Scotland was founded on the inflationist schemes which the Scotsman John Law had tried unsuccessfully to get the Bank of Scotland to adopt in 1705.

In a mere three years, the Ayr Bank managed to create a tremendous amount of unbacked paper, and when it finally collapsed in 1772 losses amounted to two-thirds of a million pounds, a staggering amount for those days.

But the intriguing thing is that the Ayr Bank's collapse had limited repercussions. It took with it only eight small private banks in Edinburgh. This is largely because of a well-developed clearinghouse mechanism that the large Scottish banks employed. They accepted each others' notes and returned those notes to the issuing bank. Suspicious of the Ayr Bank's issue, other banks made a practice of quickly returning Ayr's notes to it. When the collapse came, they were not affected. Nevertheless, to insure public confidence (and get their own notes into wider circulation) the two largest banks, the Royal Bank and the Bank of Scotland, announced that they would accept the bankrupt bank's notes. This was not as mad as it may appear. The collapse had few rippling effects because of Scotland's extraordinary practice of unlimited liability on the part of the bank's shareholders. So Ayr's loss was borne completely by the 241 shareholders, who paid all creditors in full.

A helluva a lot different than the recent crisis where taxpayers instead of Goldman Sachs shareholders JPMorgan shareholders paid the losses. But this 1772 crisis is the model, resolved by private parties and limited in damage, that Roubini is suggesting is more damaging than the model used to deal with current crises that get every one to pay for the recklessness of a few.

The 1792 crisis was a direct result of the First Bank of the United States. The bank was founded by Congress in 1791 at the insistence of Alexander Hamilton. In other words it was a central bank. As Ron Paul reports:

The bank immediately fulfilled its inflationary potential by issuing millions of dollars in paper money and demand deposits pyramiding on top of $2 million in specie.

Dacid Cowen backs-up Ron Paul's account and explains how the halt in the central bank money printing resulted in the crash, the way all such manipulations always do:

The Bank had an enormous impact on the economy within two months of opening its doors for business by flooding the market with its discounts (loans) and banknotes and then sharply reversing course and calling in many of the loans. Although the added liquidity initially helped push a rising securities market higher, the subsequent drain caused the very first U.S. securities market crash by forcing speculators to sell their stocks. The largest speculator caught in the financial crisis was William Duer. When he went insolvent in March 1792, the markets were temporarily paralyzed. This so-called "Panic of 1792" was short lived as again Secretary Hamilton (as in the previous year during the script bubble) injected funds by buying securities directly and on behalf of the sinking fund. Yet incidents like the Panic of 1792 and the script bubble would be remembered for many years by opponents of the Bank who were still in steadfast opposition to the Hamilton inspired institution.

Thus, we see that Roubini's throwing out dates of financial crashes completely distorts the picture. The first date Roubini cites was a small crisis that hurt mostly the shareholders of the bank involved. The second crisis had nothing to do with the private sector, it was the result of a central bank.

But Roubini is only getting warmed up, he then claims that current crises, during the watch of the Federal Reserve, were not caused by the Fed:

Has he not seen the Fed rock and roll manipulation of the Fed money supply. The last crisis, by the way, I chronicled coming in real time: here, here, here, here, here, here, here and here.

Does Roubini really not think the Federal Reserve was active in the markets between 1990 to 2009? Here's the chart of money printing during that period. Oh yes, just as Roubini suggests, nothing going on here---just a minor increase of a near10X in the money supply:

Now, Roubini comes out with this total distortion of the debate:

Lets shut down the Fed/all banks & go back to that bucolic autartic economy of barter where i sell you the potatoes i grow for your tomatoes.

No one is arguing that we should go back to barter as Roubini implies. Ron Paul has consistently said that the medium of exchange should be left up to the free markets. He has regularly introduced a bill in Congress calling for a free market in currencies. As a matter of fact on the floor of Congress on February 13, 2008, Congressman Paul rose to speak where he made it clear that a complex economy can not exist under barter and that a medium of exchange must exist to make for the smooth flow of commerce:

Madame Speaker, I rise to introduce the Free Competition in Currency Act of 2009. Currency, or money, is what allows civilization to flourish. In the absence of money, barter is the name of the game; if the farmer needs shoes, he must trade his eggs and milk to the cobbler and hope that the cobbler needs eggs and milk. Money makes the transaction process far easier. Rather than having to search for someone with reciprocal wants, the farmer can exchange his milk and eggs for an agreed-upon medium of exchange with which he can then purchase shoes.

This medium of exchange should satisfy certain properties: it should be durable, that is to say, it does not wear out easily; it should be portable, that is, easily carried; it should be divisible into units usable for every-day transactions; it should be recognizable and uniform, so that one unit of money has the same properties as every other unit; it should be scarce, in the economic sense, so that the extant supply does not satisfy the wants of everyone demanding it; it should be stable, so that the value of its purchasing power does not fluctuate wildly; and it should be reproducible, so that enough units of money can be created to satisfy the needs of exchange.

Over millennia of human history, gold and silver have been the two metals that have most often satisfied these conditions, survived the market process, and gained the trust of billions of people. Gold and silver are difficult to counterfeit, a property which ensures they will always be accepted in commerce. It is precisely for this reason that gold and silver are anathema to governments. A supply of gold and silver that is limited in supply by nature cannot be inflated, and thus serves as a check on the growth of government. Without the ability to inflate the currency, governments find themselves constrained in their actions, unable to carry on wars of aggression or to appease their overtaxed citizens with bread and circuses.

Nouriel Roubini is either ignorant of financial history, or attempting to keep the populace ignorant. Roubini should stop tweeting on history until he is willing to tweet the facts. The rest of us should continue to study history so that we will be aware when central bank propagandists are attempting to distort history in front of our very own eyes.

24 comments:

You do truth-seekers a service here with this post so I don't mean this as criticism because I think you really nailed Roubini for his ignorance/deceit in this regard, but you're missing the real point here:

Roubini is implicitly arguing that, post-Fed, each time the Fed has come to the rescue in a financial panic/crisis it is or will be the last time. Then it happens again, and they intervene, for the last time. Somehow the whole "they keep intervening" doesn't seem in his mind to contradict the "for the last time" bit.

What's more, he is implying that the final day of reckoning can be indefinitely put off via Fed intervention. That there are free lunches. That everyone can have their cake and eat it too, with no bad or faroff consequences.

The man doesn't get economic theory. Is it any wonder his interpretation of and conclusion-drawing from history is completely off kilter?

The previous booms and busts were all caused by government intervention in the form of inflationary monetary policy and in the form of meddling in the banking industry. There were central banks in the nineteenth century, and they caused the Panics of 1819 and 1837. After the second central bank was abolished, there was only one panic, the most mild of all, before the federal government involved itself in banking again in 1863. The Panic of 1857 was caused by the inflationary practices of the state-run banks, mainly in the North. The southern states, which by this time had hard-money policies, were barely hit by this panic. After 1863, the government once again involved itself in banking with the National Banking Acts. Government inflation to pay for the war, as well as the federally chartered national banks, caused the Panic of 1873, as widely accepted at the time. (See the secretary of the treasury's speeches from this period.) The Panic of 1893 was caused by additional government meddling in the form of inflation created by the Silver Purchase Act, as well as the exceedingly high McKinley Tariff. Bottom line -- the government intervention in the economy caused all those pre-Fed panics, none of which was bad as the Great Depression and our current endless depression, not the mention the innumerable smaller booms and busts in between. We libertarians must repeatedly hammer these points. Hard-money economists of the nineteenth century -- the precursors to the Austrians -- acknowledged government intervention as the cause of the panics. Rothbard writes in detail about all these panics in The History of Money and Banking in the United States and The Mystery of Banking. See also The Panic of 1819, as well as the writings of the original economists. The problem is not central banking per se but government control of the money supply and interference in the banking industry. Currently, the central bank is the instrument of government control of the money supply.

The Great Roubini's Vanishing Act - he vanished the 1920-21 recession, which provides a text book case refuting the Keynesians.I quote Bob Murphy:

"To restore fiscal and price sanity, the authorities implemented what today strikes us as incredibly “merciless” policies. From FY 1919 to 1920, federal spending was slashed from $18.5 billion to $6.4 billion—a 65 percent reduction in one year. The budget was pushed down the next two years as well, to $3.3 billion in FY 1922.

On the monetary side, the New York Fed raised its discount rate to a record high 7 percent by June 1920. Now the reader might think that this nominal rate was actually “looser” than the 1.5 percent discount rate charged in 1931 because of the changes in inflation rates. But on the contrary, the price deflation of the 1920–1921 depression was more severe. From its peak in June 1920 the Consumer Price Index fell 15.8 percent over the next 12 months. In contrast, year-over-year price deflation never even reached 11 percent at any point during the Great Depression. Whether we look at nominal interest rates or “real” (inflation-adjusted) interest rates, the Fed was very “tight” during the 1920–1921 depression and very “loose” during the onset of the Great Depression."

While those of us that know our history of banking in the US understand that Roubini is being intellectually dishonest in his tweet, but let's pretend he's not. The price for the slightly better stability that he sees as a result of the central bank is the destruction of 97% of the value of our currency. I think that's a pretty steep price to pay for the stability we've gotten.

M2 growth is 6x rather than 10x.Use a logarithmic scale rather than a linear one for an honest look at growth over time. Any discussion of "printing money" should include the context of real GDP growth and the price level.

Anon@9:54 The M2 increase is a shitload of cash being poured into connected fatcat's pockets whichever way you slice it. And real GDP and the price level are aggregates of goods and services in many different categories over the entire economy and as such a almost worthless figures. As the man said "you can't eat an Ipad"

The old question...evil or stupid? Can Roubini really be that ignorant? Central banking or government meddling in banking was involved in almost all of the calamities listed. Just because it wasn't called "Federal Reserve Bank" at that time doesn't mean it wasn't a central bank.

Also, what's up with the central banking or barter economy argument? Shouldn't a man who teaches at his level have to have a grasp on logic and argument?

The Federal Reserve provides currency. People trade with currency. Thus, if there is no Federal Reserve, there will be no trade!

I think I can spot a fallacy or two...

Sure, you can count the number of recessions before after the Fed was formed, then tweet that over and over again and throw in some words like voodoo and deregulation, but unless you examine the causes and effects of each, it won't teach you much.

"The M2 increase is a shitload of cash being poured into connected fatcat's pockets whichever way you slice it."

Go to FRED and pull up M2. Then make the scale logarithmic. Rather than the parabolic increase depicted in the linear graph, you'll see that the growth rate has been very consistent since about 1995. What would Friedman say about that?

The growth trend is higher than the 1987-95 period, but lower than the 1980-87 period.

"And real GDP and the price level are aggregates of goods and services in many different categories over the entire economy and as such a almost worthless figures."

Really? "Almost worthless"? How do you measure growth in the economy and price level? And if you find "aggregates over the entire economy" problematic, why would you find M2 (or any other monetary aggregate) to be meaningful?

I can understand a guy being clueless enough to think that the late 90's tech bubble was a private sector mania. But Roubini must be smoking crack if he thinks the S&L and housing bubbles were initiated by a private sector mania. The guy must be delusional.

It is also always left out of these discussions how often the recessions/depressions of the 1800s were caused by severe regulation in terms of branch banking. When banks in states were only allowed to have one, or just two or three banks, they were far more likely to be taken down in regional disasters or areas that would have otherwise been spread out had multiple bank branches been allowed.

Just point Roubini to Panama. Founded just a few years before the Fed with a constitution that forbids forced fiat currencies and, as a result, central banking. They also have no capital controls and no government FDIC-style bailout guarantees. How does their number of financial crises (hint: ZERO!) over the past century stack up to the U.S.'s?